International transfer pricing - applying the arm's length principle

The arm's length principle uses the behaviour of independent parties as a guide or benchmark to determine how income and expenses are allocated in international dealings between related parties. It involves comparing what a business has done and what a truly independent party would have done in the same or similar circumstances. This principle is supported by all OECD countries.

You should carefully consider the terms and conditions of any international dealings with related parties to ensure you properly allocate income and expenses between Australia and other countries when preparing your tax return. Australia's double tax agreements and domestic law require income and expenses to be allocated according to the arm's length principle for tax purposes.

We generally allocate resources to transfer pricing cases according to the perceived risk to revenue of a business not complying with the arm's length principle in relation to international dealings with related parties.

In assessing compliance with the arm’s length principle, you should exercise commercial judgment about the nature and extent of documentation appropriate to your particular circumstances. Both the ATO and the OECD state that businesses should not be expected to prepare or obtain documents beyond the minimum needed to reasonably assess whether their dealings with related parties comply with the arm’s length principle.

Businesses should consider the level of certainty they wish to achieve, having regard to the impact of international dealings with related parties on their overall business. This assessment will determine the level of risk to which a business is exposed.

Businesses risk a transfer pricing audit if they do not have proper processes to determine arm's length prices and cannot demonstrate to us the methods they have used to determine their prices. They also risk a transfer pricing adjustment and penalties as a consequence of any audit.

In the event of a transfer pricing audit adjustment, any penalties will have regard to the new domestic law rules in respect of the extent and quality of the documentation kept. Refer to TR 2014/8 – Income tax: transfer pricing documentation and Subdivision 284-E.

See also:

International transfer pricing - introduction to concepts and risk assessment discusses the arm's length principle and comparability, and the risk of a transfer pricing review or audit.

    Last modified: 20 Oct 2015QC 17108